International Business

7e

by Charles W.L. Hill

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 14

Entry Strategy and Strategic Alliances

Introduction

Firms expanding internationally must decide:  which markets to enter  when to enter them and on what scale  which entry mode to use Entry modes include:  exporting  licensing or franchising to a company in the host nation  establishing a joint venture with a local company  establishing a new wholly owned subsidiary  acquiring an established enterprise

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Introduction

Several factors affect the choice of entry mode including:  transport costs  trade barriers  political risks  economic risks  costs  firm strategy  The optimal mode varies by situation – what makes sense for one company might not make sense for another

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Basic Entry Decisions

Firms entering foreign markets make three basic decisions: 1.

which markets to enter 2.

when to enter those markets 3.

on what scale to enter those markets

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Which Foreign Markets?

 The choice of foreign markets will depend on their long

run profit potential

 Favorable markets are

politically stable

developed and developing nations with

free market systems

and relatively

low inflation rates

and private sector debt  Markets are also more attractive when the product in question is

not widely available

and satisfies an

unmet need

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Timing Of Entry

 Once attractive markets are identified, the firm must consider the timing of entry  Entry is

early

when the firm enters a foreign market before other foreign firms  Entry

is late

when the firm enters the market after firms have already established themselves in the market

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Timing Of Entry



First mover advantages

are the advantages associated with entering a market early First mover advantages include:  the ability to

pre-empt

rivals and

capture demand

by establishing a strong brand name  the ability to build

up sales volume

in that country and ride down the

experience curve

ahead of rivals and gain a cost advantage over later entrants  the ability to create

switching costs

that tie customers into products or services making it difficult for later entrants to win business

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Timing Of Entry

 First mover disadvantages are disadvantages associated with entering a foreign market before other international businesses First mover disadvantages include: 

pioneering costs

- arise when the foreign business system is so different from that in a firm’s home market that the firm must devote considerable time, effort and expense to learning the rules of the game Pioneering costs include:  the costs of business failure if the firm, due to its

ignorance of the foreign environment, makes some major mistakes

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Scale Of Entry And Strategic Commitments

 After choosing which market to enter and the timing of entry, firms need to decide on the

scale of market entry

 Entering a foreign market on a

significant scale

is a major

strategic commitment that changes

the competitive playing field  Firms that enter a market on a significant scale make a strategic commitment to the market (

the decision has a long term impact and is difficult to reverse)



Small-scale entry

has the advantage of allowing a firm to learn about a foreign market while simultaneously limiting the firm’s exposure to that market

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Summary

 There are no “right” decisions when deciding which markets to enter, and the timing and scale of entry, just decisions that are associated with different levels of risk and reward

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Entry Modes

These are six different ways to enter a foreign market: 1.

exporting 2.

turnkey projects 3.

licensing 4.

franchising 5.

establishing joint ventures with a host country firm 6.

setting up a new wholly owned subsidiary in the host country

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Exporting

 Exporting is a common

first step

in the international expansion process for many manufacturing firms  Later, many firms switch to another mode to serve the foreign market

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Exporting

Exporting is attractive because:  it avoids the

costs

operations of establishing local manufacturing  it helps the firm

achieve experience

curve and location economies Exporting is unattractive because:  there may be

lower-cost manufacturing locations

 high

transport costs

and tariffs can make it uneconomical 

agents in a foreign country may not act

in exporter’s best interest

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Turnkey Projects

 In a turnkey project , the

contractor

agrees to

handle

every detail of the project for a foreign client, including the training of operating personnel  At completion of the contract, the foreign client is handed the "key" to a plant that is ready for full operation  Turnkey projects are common in the chemical,

pharmaceutical, petroleum refining

, and metal refining industries

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Turnkey Projects

Turnkey projects are attractive because:  they are a way of earning

economic returns

from the

know-how

required to assemble and run a technologically complex process  they can be

less risky

than conventional FDI Turnkey projects are unattractive because:  the firm that enters into a turnkey project

may create a competitor

 if the firm's process

technology is a source of competitive advantage

, then selling this technology through a turnkey project is also selling competitive advantage to potential and/or actual competitors

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Licensing

 A licensing agreement is an arrangement whereby a licensor

grants the rights to intangible property

to another entity (the licensee)

for a specified time period

, and in return, the licensor receives a

royalty fee

from the licensee  Intangible property includes

patents, inventions, formulas, processes, designs, copyrights, and trademarks

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Licensing

Licensing is attractive because:  the firm does not have to bear the development

costs

and

risks associated

with opening a foreign market  the firm

avoids barriers

to investment  firms with intangible property that might have business applications can

capitalize

on market opportunities without developing those applications itself

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Licensing

Licensing is unattractive because:  the firm doesn’t have the

tight control

over manufacturing, marketing, and strategy required for realizing experience curve and location economies  it limits a firm’s ability to

coordinate strategic

moves across countries by using profits earned in one country to support competitive attacks in another  proprietary (or

intangible) assets could be lost

 One way of reducing this risk is through the use of cross-licensing agreements where a firm might license intangible property to a foreign partner, but requests that the foreign partner license some of its

valuable know-how

to the firm in addition to a royalty payment

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Franchising

 Franchising is basically a

specialized form of licensing

in which the franchisor

not only sells intangible property

to the franchisee, but also insists that the franchisee agree to abide by

strict rules as to how it does business

 Franchising is used primarily by service firms

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Franchising

Franchising is attractive because:  Firms

avoid many costs and risks of ope

ning up a foreign market  Firms can

quickly build a global

presence Franchising is unattractive because:  the geographic distance of the firm from its foreign franchisees can make poor quality difficult for the franchisor to detect

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Joint Ventures

 A joint venture is the establishment of a firm that is

jointly owned by two or more otherwise independent firms

 Most joint ventures are 50:50 partnerships

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Joint Ventures

Joint ventures are attractive because:   they allow the firm to

benefit from a local partner's knowledge

systems, and business systems the costs and risks of opening a foreign market

are shared

of the host country's competitive conditions, culture, language, political with the partner  When

political considerations

make joint ventures the only feasible entry mode  Joint ventures are unattractive because:  the firm

risks giving control

of its technology to its partner   the firm may

not have the tight control

shared ownership can

lead to conflicts

over subsidiaries need to realize experience curve or location economies and battles for control if goals and objectives differ or change over time

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Wholly Owned Subsidiaries

 In a wholly owned subsidiary , the firm owns 100 percent of the stock Firms can establish a wholly owned subsidiary in a foreign market:  setting up a new operation in the host country  acquiring an established firm in the host country

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Wholly Owned Subsidiaries

Wholly owned subsidiaries are attractive because:  they

reduce the risk

of losing control over core competencies  they give a firm the tight

control over operations in

different countries that is necessary for engaging in global strategic coordination Wholly owned subsidiaries are unattractive because:  the firm

bears the full cost and risk

of setting up overseas operations

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Selecting An Entry Mode

 All entry modes have advantages and disadvantages  The optimal choice of entry mode involves trade-offs

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Selecting An Entry Mode

Table 14.1:

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Core Competencies And Entry Mode

 The optimal entry mode depends to some degree on the nature of a firm’s core competencies  When a firm’s competitive advantage is based on proprietary

technological know-how

, the firm should

avoid licensing and joint venture arrangements

unless it believes its technological advantage is only transitory, or that it can establish its technology as the dominant design in the industry  When a firm’s competitive advantage is based on

management know-how

, the risk of losing control over the management

skills is not high

, and the benefits from getting greater use of brand names is significant

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Pressures For Cost Reductions And Entry Mode

 When pressure for cost

reductions is high

, firms are more likely to

pursue

some combination of exporting and wholly owned subsidiaries  This will allow the firm to achieve location and scale economies as well as retain some degree of control over its worldwide product manufacturing and distribution  So, firms pursuing global standardization or transnational strategies prefer wholly owned subsidiaries

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Greenfield Ventures Or Acquisitions

Firms can establish a wholly owned subsidiary in a country by:  Using a greenfield strategy - building a subsidiary from the ground up  Using an acquisition strategy

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Pros And Cons Of Acquisition

Acquisitions are attractive because:  they are

quick to execute

 they enable firms

to preempt their competitors

 acquisitions may be

less risky than greenfield ventures

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